Adventures in Sovereign Debt: Enforcing Russia’s Loan to Ukraine

In December 2015, Ukraine defaulted on a $3 billion loan made two years previously by the Russian government. Governments lend to one another all the time, but this loan was extraordinary, and so were the events that followed in its wake.

Like most government-to-government loans, this one had political motivations. For Russia, these included the desire to reward President Victor Yanukovych for backing out of an Association Agreement that would have deepened Ukraine’s ties to the European Union. The structure, however, was unusual for a government-to-government loan. Whereas governments typically lend funds directly, the Russian loan took the form of tradable Eurobonds (the entirety of which were purchased by Russia’s sovereign wealth fund). The bonds also included some unusual clauses, such as debt-to-GDP ratios, which gave Russia the power―unusual for an official creditor―to destabilize Ukraine’s private debt stock.[1]

And then, of course, there is the small fact that the two governments are now engaged in what might politely be called “hostilities.” In February 2014, President Yanukovych was deposed and subsequently left Ukraine. There are conflicting and politically-inflected accounts about what happened thereafter, but the basic facts are not seriously in dispute. These include: (i) that Russia annexed Crimea, (ii) that Russia is engaged in what amounts to a proxy war by supporting a separatist insurgency in eastern Ukraine, and (iii) that these developments have significantly and negatively affected Ukraine’s economy and ability to access private capital.

In February 2016, Russia took Ukraine to court. (Technically, the sovereign wealth fund owns the bonds, and The Law Debenture Trust Corporation filed the lawsuit as bond trustee, but Russia has made clear that it is calling the shots.) The bonds are governed by English law and stipulate to the jurisdiction of English courts, so the suit is in some respects a garden variety contract case. But, of course, it is much more than that. Government creditors typically resolve debt disputes through diplomatic channels or under the auspices of organizations such as the Paris Club, not through litigation. The dispute over the Russian loan starkly illustrates why. Courts are not accustomed to using the dry language of contract law to resolve such politically- and militarily-charged disputes. Nevertheless, that is the position in which the English High Court of Justice now finds itself. It must rule on the merits of Ukraine’s contract-law defenses to the loan, including lack of capacity, duress, and the doctrines of impracticability and prevention.[2]

On the merits, it seems clear that Ukraine should not be required to repay the loan, at least on Ukraine’s version of events. That version goes something like this: Russia made a $3 billion loan to prop up a friendly kleptocrat, with the understanding that, if unstable political and economic conditions worsened, the loan could not be repaid. When a new, pro-European government entered the scene, Russia then embarked on a program of destabilization. The resulting conflict and loss of territory effectively prevent Ukraine from repaying the loan without jeopardizing its access to IMF emergency funds or defaulting on promises made in connection with its 2015 debt restructuring (in which Russia declined to participate).

The doctrine of prevention – embraced by both English and U.S. law – is tailor-made for facts like these. Under that doctrine, if one party to a contract materially impairs the other’s ability to perform, the latter’s failure will be excused. To be a bit tendentious: Assume L lends money to B, a widget manufacturer. L thereafter funds a group of anti-widget extremists, whose members burn several of B’s factories to the ground. Beyond other obvious legal consequences―such as criminal and civil liability―it cannot seriously be disputed that L’s conduct excuses B’s duty to repay.[3] The doctrine of impracticability is another possibility. That doctrine excuses non-performance in certain circumstances when post-contract events make performance impossible or extremely difficult. The impracticability defense is a tougher one for Ukraine. Among other reasons, courts generally reject the doctrine of impracticability when asserted by borrowers.[4] Yet as I explain in a recent essay, Ukraine’s impracticability argument is also plausible.[5]

The difficulty Ukraine faces has little to do with the legal merits of its defenses. The real problem is that the defenses invite the court to take sides in politically-charged disputes over the nature and legitimacy of Russia’s involvement in the east of Ukraine, the annexation of Crimea, and similar matters. Few judges will be eager to wade into such murky waters. Yet responsibility for this situation lies primarily with the Russian government. Rather than press its claims in the usual official channels, it has elected to enforce the loan as if the Russia were no different from any private creditor. It might be understandable for judges to hesitate before weighing in on such a politically-charged dispute, but Russia’s insistence on acting like a private creditor leaves little choice.

[2] In its Defence, Ukraine describes the latter two doctrines as “implied terms” in which Russia agreed not to deliberately interfere with Ukraine’s ability to pay or to seek repayment if impracticable for Ukraine.

[3] To be sure, the loan’s structure adds complexity. Russia’s conduct cannot automatically be attributed to its National Wealth Fund (NWF), or to subsequent holders of the bonds. But such complexities do not necessarily defeat these defenses.

[4]See, e.g., Bank of America v. Shelbourne Dev. Group, Inc., 2011 WL 829390 (N.D. Ill. Mar. 3, 2011). The presumption is that the borrower assumes the risk of events that cause it to run out of money.

This post comes to us from Professor Mark C. Weidemaier of the University of North Carolina at Chapel Hill – School of Law. It is based on his recent article, “Contract Law and Ukraine’s $3 Billion Debt to Russia,” available here.